Third-Best Carbon Taxation: Trading Off Emission Cuts, Equity, and Efficiency

Frederick van der Ploeg, Armon Rezai and Miguel Tovar Reaños

Journal of the Association of Environmental and Resource Economists, 2025, vol. 12, issue 4, 1023 - 1058

Abstract: We analyze carbon taxes, lump-sum climate dividends, and changes to the level and progressivity of the income tax system that optimally trade off carbon emissions, equity, and efficient raising of public revenue while preserving budgetary neutrality and not using individualized lump-sum transfers. Such “third-best” policies include a carbon tax that exceeds the Pigouvian level and recycling of all carbon tax revenue via climate dividends for high (and our preferred) degrees of inequality aversion, even if this implies higher income taxes to meet existing revenue requirements. The carbon tax, climate dividends, and the progressivity of the income tax rise with the degree of inequality aversion. Our results are derived from a microsimulation model estimated from German data, which includes heterogeneous households, an exact affine Stone index demand system, and endogenous labor supply. We decompose the welfare effects of policy into emissions, equity, and efficiency components for different degrees of inequality aversion and climate damages.

Date: 2025
References: Add references at CitEc
Citations:

Downloads: (external link)
http://dx.doi.org/10.1086/732802 (application/pdf)
http://dx.doi.org/10.1086/732802 (text/html)
Access to the online full text or PDF requires a subscription.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ucp:jaerec:doi:10.1086/732802

Access Statistics for this article

More articles in Journal of the Association of Environmental and Resource Economists from University of Chicago Press
Bibliographic data for series maintained by Journals Division ().